Are tax breaks necessary to attract business?

December 18, 2018

 

Defend and grow. It's a mantra in Lansing and in job centers throughout Michigan. Defend the industries we have; grow the economic base. For business leaders, lawmakers and others focused on economic development that means convincing businesses that the Great Lakes State and their local community is the best place to locate their business. Doing so requires an educated and talented workforce, strong infrastructure and numerous other factors that play into successful business development.

 

If none of those things work – try throwing money at them.

 

"We have a very broad set of tools to drive job creation and investment in Michigan, beginning with promoting a strong supply chain, talented work force and the largest concentrations of engineers in the world. We have a great business climate and low cost of living. We use those as a starting point. From there, we do utilize a wide range of tools. And business tax incentives are one of those tools," said Josh Hundt, executive vice president and chief business development office of the Michigan Economic Development Corporation (MEDC). "Tax incentives are utilized, but we work to be strategic in using them in combination with other tools.

 

"We work to compete for projects that we feel we have a chance to win. We utilize and evaluate incentives in terms of net positive impact that we think the project will bring to Michigan, and the overall strengthening in the economy."

 

In tool terms, the MEDC in combination with the Michigan Strategic Fund can offer tax abatements, loans, grants and other assistance  combinations to offer potential businesses a variety of packages to persuade relocation or expansions in the state. In simpler terms: if we can't woo you with our infrastructure, workforce, business regulations and quality of life, we'll give you special treatment and a sack of money to bring us jobs.

Essentially, tax incentives and abatements are agreements between a company and local government or the state to forgive a certain amount of property or business taxes for a designated number of years. In return, the companies receiving them agree to locate in a specific place, develop a minimum number of jobs and invest in that community. Those who favor the use of tax incentives insist they are necessary in order to attract and retain businesses. However, many analysts say tax abatements play only a small role in a company's decision on its location – and that abatements divert much-needed tax payments from areas that need them the most.

 

"Our issue with tax abatements for the longest time has been, when you look at how they are used in other states, it's the commercial model of a loss leader," said Eric Lupher, president of the Citizens Research Council of Michigan. "If I can bring you into my store with a sale on whatever cereal, but you're buying other things, then I'm making a profit. A lot of states offer the abatement, but their locals are able to capitalize. For Michigan, it's only cities that levy an income tax. The others only benefit from property tax, so the only way you can benefit is if the company stays for 20 or 30 years, otherwise they aren't really winning.

 

"Maybe if they are employed and living there, but most places where manufacturing is, people don't live there. You could locate in Southfield and have people from Lake Orion to the north, and Dearborn and Brownstown, so who is benefitting? The region – but not necessarily the local government. It's sort of a mismatch on the benefit and cost."

 

Justin Robinson, vice president of business attraction for the Detroit Regional Chamber, said with so many states and local governments offering incentives, they are a virtual requirement of the process.

 

"They are definitely part of the conversation," Robinson said. "The reality is that not just nationally, but globally, incentives exist. Other countries, states and regions are armed with a toolbox of services and programs to build the business case: why here rather than someplace else? Tax incentives are part of the toolbox."

 

Robinson said while tax incentives are on the list of items used to reel in investment projects, they are really near the bottom of that list in terms of priorities. The most important factor, he said, is workforce, and whether a community's workforce allows the company to recruit the appropriate people to allow growth. Real estate and vacancy rates, supply chains and utilities are also factors.

 

"I think it happens, but I don't think they are making decisions based on (abatements). The decision doesn't start that way," he said. "Those that are truly people or innovation driven, and Amazon is an example, they were looking at what community can guarantee delivery of enough educated people to drive the future of their business. Incentives came after the fact."

 

Last year, when Amazon was shopping locations for its massive, multi-billion dollar H2Q project, Michigan offered the internet giant massive tax breaks for two decades, as well as the development of a $120 million talent development program. As it was later learned, Michigan wasn't even among the finalist cities in the running. Ultimately, Amazon chose to locate in two locations: Arlington, Virginia and New York's Long Island City, where the company will invest about $2.5 billion in each location to bring in more than 25,000 new jobs, over time.

 

Carl Davis, research director for the Washington D.C.-based Institute on Taxation and Economic Policy, agreed that businesses aren't making their decisions based on tax incentives. If that's so, why are they being offered in the first place?

 

"Companies are finding out it can be tremendously profitable to seek out these subsidies, even for projects they may had done anyway," Davis said. "There's really no way for governments to know what a company is planning and what the actual tipping point is. That means a lot of dollars are wasted. The (incentive) may be bigger than it needed to be, or not been necessary. But it's in the company's best interest to convince officials that large subsidies are needed."

 

Efforts across the country to court Amazon into investing billions in their community are an example, Davis said, of why tax abatements aren't necessary.

 

"They didn't choose the biggest tax incentive offer, they based their decision on business fundamentals, particularly talent, and where they thought they would be able to get the skills they needed," Davis said. "Of course, those states offer incentives, too. It's standard practice."

 

With businesses expecting sizable tax breaks as part of the expansion process, Davis said the overall effect is a problem as it pits states against each other, with each trying to outdo the other.

 

"You can see how this isn't a particular great thing for the nation as a whole," he said. "If they competed not based on who can offer the biggest payout, but instead on business fundamentals, you probably would have had the same outcome as we see now, but without the massive taxpayer handout to go along with it. The story repeats itself. It's very common for companies to play states or localities off each other. Amazon did it on a much bigger scale."

 

Because tax abatements can be extremely valuable to a business, Davis said it's not uncommon for businesses to give the impression that they are needed, even if they aren't. In other words, it might not be beyond a business to bluff in order to get the best deal available.

 

"Incentives would be a better deal if it was a one-time, up front thing to get them to invest, but we are seeing that's not the case," he said. "We are seeing that when a deal lapses and they start paying normal tax rates, they start getting footloose, or pretend to be. Now you need to offer them a new package or they are going to move. These aren't one-time deals; they become used as special treatment.

 

"Sometimes they may actually be thinking of moving, but oftentimes they aren't. Lawmakers aren't psychic. They can't know for sure. Oftentimes it's easier to talk about moving than to actually move, and often just talking about it is enough."

Consider for example, a number of tax incentives approved in late November by the Michigan Strategic Fund to bring in an estimated $1 billion in investment into Detroit, including the rehabilitation of the city's long-vacant Michigan Central Station in the city's Corktown area, which Ford Motor Company plans to transform into a new campus. The site will be the hub for Ford's vision for autonomous and electric vehicles, as well as design mobility services and solutions for urban environments. The project is expected to bring about $740 million in private investment and 2,500 jobs directly with Ford, and another 1,500 job with Ford's partners and suppliers.

 

The $208 million abatement, which came because Ford is locating in a state-designated Renaissance Zone, followed a 12-year abatement approved by the city of Detroit valued at $27 million. Even with the abatement, the Detroit Economic Growth Corporation (DEGC) estimates the project will provide about $370.7 million in net fiscal benefits to the city and other taxing jurisdictions.

 

However, even before the tax abatements were approved, Ford Executive Chairman Bill Ford Jr., said the plans to revitalize the area had been an idea for years. Whether or not the finalization of a deal actually hinged on tax abatements isn't known.

 

Still, Robinson, with the Detroit Regional Chamber, said incentives offered in the Ford deal could have been a tipping factor in the deal

 

"Does Ford have the capital for that project? Clearly it does," he said. "But can they justify making that deal to the board without incentives? It's probably not impossible, but it would be difficult. I think they looked at the multipliers and impacts of that project. To put that iconic image of blight and decay in the city back into the highest position of use in its political space – there's a careful calculation there. They said, 'we need to be a partner with Ford,' and the outcome and what it means is very real and important."

While the promise of new jobs is hard to pass up, not everyone is convinced that tax abatements are the right way to build the economy. Critics say large tax breaks give away much needed state and local tax dollars. In a city emerging from bankruptcy in a state struggling to find money to fix its crumbling roads and fund its education system, some are calling for an end to tax abatements.

 

In November, General Motors announced shuttering five manufacturing plants in North America, including two in metro Detroit, as well as layoffs for nearly 6,000 salaried workers. In all, the company plans layoffs or buyouts for more than 14,000 workers across the country. The fact that General Motors is the state's largest recipient of tax subsidies – an estimated $3.3 billion since 2014 – makes the closures a particularly hard pill to swallow.

 

In a rare instance of agreement, the announcement had both president Trump and local organizers pushing for a return of tax abatements by the company. 

 

In December, Good Jobs First.org released a report on the cost of tax abatements to public education. The report, "The New Math on School Finance: Adding Up the First-Ever Disclosure of Corporate Tax Abatements' Cost to Public Education," found school districts in Michigan, South Carolina, New York, Louisiana, Ohio, Oregon, Missouri, Pennsylvania, Texas and Georgia lost $1.6 billion in school tax revenue from tax abatements. That's about $77.6 million in 347 Michigan districts, out of 587, examined in the report. 

 

The $77.6 million figure for the latest fiscal year includes about $20 million not collected by Michigan's East China Schools district and $11.7 million by Troy Schools, in Oakland County. Another $4.5 million was diverted in the Lamphere Schools district; about $1.7 million in Oakland Schools; $1.6 million in Coopersville Area Public Schools; $1.4 million each from school districts in Lansing, Utica and Kent County; $1.3 million from Ottawa Area Intermediate Schools; $1.1 million from both Trenton and Riverview school districts; and $1 million from Grand Ledge Public Schools. Other districts lost out on funding below $1 million. 

 

The report comes on the heels of a new accounting rule, GASB Statement 77, that has thousands of public school districts reporting, for the first time, how much revenue they lost to corporate tax breaks granted in the name of economic development. However, even with the new rule in place, more than half of the districts whose financial reports were inspected failed to report losses associated with tax abatements.

 

"When it comes to protecting the cornerstone of our nation's workforce development system, Americans deserve the right to know where their tax dollars are – and are not – going," the study's authors wrote. "There is a longstanding tension between costly economic development tax breaks and adequate funding for education and other public goods and services. Those public investments are proven economic development winners, so this is no small debate."

 

Another criticism about tax abatements is the claim that the state isn't properly assessing the value of abatements it does grant.

 

A 2017 report by the Pew Charitable Trust, "How States Are Improving Tax Incentives for Jobs and Growth," looked at how 27 different states are measuring the results of tax incentives. The report placed Michigan at 23rd overall, saying it is "trailing" in its efforts compared to other states.

 

Among the report's findings was Michigan's failure to adopt a plan for regular evaluation of tax incentives, as well as the state's shift in economic development strategy to move away from abatements, then return to them. Further, it notes the state's budget challenges stemming from MEGA tax credits, but failure to provide better information.

 

"The state has shifted strategy in recent years, investing heavily in tax incentives at some points and scaling back at others," the authors said. "But, lacking an ongoing process for evaluating incentives, it made the shifts without adequate information about whether the programs were working or how they might be improved."

 

Nationally, some of the earliest modern day business tax incentives were offered by southern states looking to attract new technology to their agricultural economies. As taxes soared throughout the country in the 1930s, more and more states began offering tax abatements to spur incentives for work and investment. Southern programs spread across the country following the second World War, with 15 states offering tax abatement programs by 1964, according to a 2005 Indiana University study. 

 

Michigan's first modern day business tax abatements came about in 1974 with the passage of the Industrial Property Tax Abatement Program. The program is still in use and is one of the most common state tax incentives available for use by local governments.

 

Industrial property tax abatements are granted by local municipalities where the project is located. The process must include a public hearing on the matter where the municipality approves the establishment of an Industrial Development District (for a new project) or a Plant Rehabilitation District (for rehabilitation projects). Once a district is established, the company may apply for an abatement on real and personal property tax for up to 12 years.

 

Additional changes were made to the state's economic development system, with the Michigan Economic Growth Authority (MEGA) formed in 1995. Under the MEGA program, businesses were provided tax credits to businesses for locating, expanding and retaining jobs in Michigan. Among the greatest recipients were Detroit's automakers. While the program has since stopped taking any new applicants, the state's obligation under the MEGA program totaled $9 billion by 2015, with commitments expected to continue until 2032.

Governor Snyder in 2011 slashed abatement programs, instead focusing on turning over the state's overall business climate. However, new programs, including the Michigan Business Development Program (MBDP) and the Good Jobs for Michigan Program, were developed and approved in recent years. The MBDP provides grants, loans and other assistance to businesses, while Good Jobs allows businesses to capture some payroll taxes, depending on the average annual wage and number of certified jobs. The latter program is limited to 15 agreements per year and $200 million in tax abatements.

 

The Good Jobs program was designed specifically to lure large projects into Michigan, including the failed 2017 bid for Taiwan-based Foxconn Technology Group. All told, Michigan offered a reported $3.8 billion in incentives to locate a flat-screen display factory in southeast Michigan, which instead is being built in Racine, Wisconsin, where that state provided the company with about $3 billion in tax incentives. It has also been reported that Detroit and the state offered Amazon $4 billion in tax credits to locate its second headquarters here.

 

Industrial tax abatements must be approved at the state and local levels. At the state level, the application is received by the Michigan Economic Development Corporation. Once approved, the business pays an Industrial Facilities Tax (IFT) instead of property taxes, which reflects the abatement savings.

 

In Rochester Hills, where the city currently has tax abatement agreements with seven different companies, tax incentives can be very effective at retaining companies that are thinking of relocating due to lower costs or incentives elsewhere, said Rochester Hills Mayor Bryan Barnett.

 

"We have been able to keep companies in Rochester Hills that otherwise may have left. And it's not just empty threats, but when you get to the point where they show us that we have to close the gap or they can't stay," Barnett said. "In those instances, we are partnering with the state and county. We have a teamed approach to keep folks here."

 

While the county doesn't offer tax abatements itself, Barnett said the city can work with the county on other economic development programs that are valuable to companies located here.

 

"For us, it's about new jobs and investment. It's better we get 50 cents of a dollar we aren't getting now, rather than nothing. But there has to be criteria for approving (tax abatements). We don't hand them out like candy."

 

Birmingham City Manager Joe Valentine said the only tax abatements the city offers are for redevelopment, which he said include brownfield redevelopment districts, which deals with environment clean-up.

 

"What we have is redevelopment, not development. The need to put in abatements isn't as much here as other communities," Valentine said. 

 

Bloomfield Township Treasurer Brian Kepes said the township doesn't offer any tax incentives or abatements.

 

"The best tool we have to attract business is our residents," he said. "That's our best resource. We have the best retailers and providers in the country, and we don't give away a penny."

Kepes said the fact that the township is 85 percent residential is unique in its approach to business development. As a result, he said, the commercial properties that exist already receive strong support from the community. With no significant amount of industrial property, he said it's not likely abatements would be utilized by the township.

 

Novi City Manager Pete Auger, who also served as Auburn Hill City Manager for seven years from 2007 to 2014, said tax incentives are used to compete with other communities, but doesn't see them as a means to poach businesses from other communities. Further, he said Novi and other communities use clawbacks on their incentives that would require a business to refund or end tax abatements if they fail to deliver on the agreed number of jobs.

 

"We use clawbacks for our incentives – that way if a company commits to X amount of years or they'll have to pay all their taxes back to the community," Auger said. "That's a win-win situation."

 

Auger said other states, including New York, Texas and California, are all competing with Michigan to attract automotive. He said incentives are just another weapon in the toolbox to lure businesses.

 

In neighboring Wixom, industrial abatements are commonplace, but not an automatic offering, said Wixom Economic and Community Development Director Debra Barker. "There are some communities that have a scale of how they award abatements. Some don't give them out at all. Wixom has always looked at applicants individually," she said.

 

In looking to fill property left vacant by Ford Motor Co. when it closed its Wixom assembly plant, Barker said tax incentives were part of the discussion.

 

"During the economic downturn, we had a group of people that were branching out in business, and the company came to Wixom and found an empty building. It needed major work, and we granted $450,000 in tax abatements," she said. "There was no electric, and there was mold in the building. Now that building is gorgeous.

 

"There are different reasons for providing tax abatements. In that case, someone was taking over a building and bringing up the standards. We don't have any specific guidelines. The state sets the guidelines."

 

Deputy Director of Oakland County Economic Development and Community Affairs Dan Hunter said industrial abatements are locally driven and typically used to retain businesses looking for expansion. He said he doesn't see tax abatements being used as a way to poach businesses from communities. And while there's a re-urbanization effort in full swing in Detroit, he said industrial facilities aren't part of the larger return to Detroit, at the moment.

 

"We don't see revitalization as a competition for industrial growth," Hunter said "There hasn't been a lot of industrial in Detroit, where companies have relocated. In the case of Quicken and others moving, that's not industrial It's likely that businesses that need more space to grow prefer to do it at the location they are at already, if that site allows for it. If not, they generally look as close to that site as possible. I don't see a lot moving from Madison Heights to Clarkston, or from Ferndale to Milford, just because there's a tax abatement there. They like to stay where they are."

 

For those communities that are using abatements, many have added localized policies to ensure clawbacks and other protections in case recipients fail to hold up their end of the deal.

 

In Auburn Hills, the city implemented a new tax incentive policy in late 2016. Under the policy, the city requires specific investment levels for four, six and eight-year abatements. The policy also requires businesses that vacate or fail to operate for the whole length of the abatement to be liable for repayment of any property tax savings, beginning in the initial effective year.

 

Lupher, with the Citizens Research Council, said clawback policies are relatively new, but have become fairly common. He said additional changes could be made at the state level to better utilize tax abatements.

 

"We could have more discretion on which communities have abatements to use as an economic tool and look at what we are gaining because of that. If it's blight or abandonment, then the communities should have to show why its important for expanding the tax base to bring them back to their once-glory," he said. 

 

Michael LaFaive, fiscal policy director at the Mackinac Center for Public Policy, said he's one of the few who have studied tax abatements, publishing several scholarly analyses of the MEGA program.

 

"From the five studies I've done, four have found zero impact (on economic development)," LaFaive said. "We have wasted billions of dollars more in incentives trying to boost job creation in Michigan than if we would have left everyone alone.

 

"We would have been better off simply with better tax reform. If they hand out incentives, they are admitting it's too expensive to do business in Michigan. Directly or indirectly, everyone else is paying a higher tax burden in order to accommodate gifts handed out by appointees and bureaucrats to a favored few they have selected. And the track record of others outside of Michigan isn't positive."

 

LaFaive said there are five basic reasons that tax abatements aren't truly necessary – they don't work; they are unfair to those who don't receive them; they are too political in determination; they are expensive; and they aren't transparent.

Michigan Representative Jim Runestad (R-White Lake) has sponsored legislation to require additional financial transparency by the MEDC. He said the issue stems from last-minute revelations by the MEDC to reveal billions in MEGA obligations while legislators were compiling the budget.

 

"All the MEGA credits came in and blew a hole in the budget. We didn't know they were coming. We thought, 'That's special, that we get these thrown in at the last second and the legislature has no clue,'" Runestad said. "The bill requires the administration to list them by size, liability and taxes foregone, all in advance of what is coming due so that it isn't represented disastrously.

 

"I still don't know why there's nothing in place, and why it was dumped after the budget was put together. If it isn't taken up this year in lame duck, I'll be putting in in next year (in the Senate)."

 

State Senator Ken Horn (R-Saginaw), who chairs the Senate Economic Development Committee, said a bill reported out of committee in early December is intended to provide better evaluation of abatements. House BIll 2052 would create the "Economic Development Incentive Evaluation Act," which would require evaluations by the Department of Technology, Management and Budget.

 

"MEGA will be gone, and that's the last remnants of the Michigan Business Tax, and we won't see that again. That's when we were bleeding manufacturing jobs. In hindsight, it's not a good way to handle tax credits," Horn said. "We think we learned our lesson."

 

While lawmakers are pushing for some reassessment in the way tax abatements are used, it's unlikely that they will be phased out in the future. Politicians will continue to push for new jobs, and if a tax abatement can help land those jobs, elected officials are willing to gamble on them. 

 

That means states and locals will continue to battle, armed with the best abatements they can offer, according to the Detroit Regional Chamber's Robinson.

 

"While things may have escalated beyond the original intent in terms of how they are deployed in some communities, it's a reality," Robinson said. "Unless you start to see a national effort for others to disarm, to be the first to consider something like that, it would be at our own loss as a community."  

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